The Most Concerning Thing About Tesla Motors Inc (NASDAQ: TSLA)

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By Mark Michaels on August 13, 2014 Company, Technology & Software

Tesla Motors Inc (NASDAQ: TSLA) has experienced one of the fastest and most incredible growths in the history of the market. In recent years, revenues for the company have been propelled sky high as well as its stock price.

However, one of the most important and concerning issues that Tesla faces is this: profitability. Tesla could stand to make some improvements in that department, given the cutbacks on the company’s yearly expectation. The company could even use some help regarding non-GAAP figures. There are plenty of reasons for Tesla and investors to be worried about this question.

Tesla Outperformed in Q2

A few weeks ago when Tesla posted its earnings report for the second quarter of 2014, it blew away analysts’ expectations by a huge margin. The electric car company reported over $857 million in revenue, high above the estimation for $810 million. The company also posted non-GAAP earnings per share of $0.11, which crushed the estimated $0.04 earnings per share.

While these numbers are impressive, Tesla did lower its expectations for the second quarter when it announced results for the first quarter. For example, the expectations for the second quarter were $0.04, and Tesla beat that figure with $0.11. However, in the first quarter, Tesla estimated that it would reach $0.27 earnings per share. Additionally, about two weeks before the release of the quarterly report, analysts were estimating about $0.06 earnings per share. Tesla’s lowered estimations caused EPS predictions to drop by more than 85% from the first quarter report to the second quarter report. Thus, the $0.11 is not as impressive as it seems, and we once again return to the issue of profitability.

Long Term Estimate Changes

The issue of profitability extends beyond a single quarter. The second quarter was one part of the problem, and it is necessary to grasp the whole picture by looking at a longer period of time.

The revenue estimates for 2014 from the third quarter of 2013 have continuously increased, and current revenues are beating those estimations. On the other hand, earnings per share estimations have dropped from the third quarter of 2013, the most recent estimation being the lowest yet at $1.08.

Tesla also announced a shutdown during the third quarter of its factory in Fremont that will affect deliveries, which has not helped EPS. Since then, analysts have pulled back their enthusiasm for their third quarter estimates. Tesla will probably beat expectations for the next quarter, but taking everything into consideration, it would not be that impressive.

What Is Causing The Concern About Profitability?

In the following chart, you can see financial data from the first six months of 2013 and 2014:

The silver lining in this chart is that the company’s gross profit has grown nicely. Tesla is also in the process of improving its gross margins as well. However, the company’s operating expenses are too high to improve profitability – its operating expenses are increasing at a rate that is nearly twice that of its increase in revenue. Additionally, the company’s interest expense doubles as well, thus causes its GAAP net loss to increase or its non-GAAP net income to drop. Additionally, Tesla estimated another 20% increase in R&D expenses and an increase of 15% for SG&A Expenses for the third quarter of this year. Both these expenses will probably rise faster than revnues.

The Increased Share Count

The following chart shows the increase in the number of shares outstanding since the third quarter of 2010.

In the second quarter of 2014, the number of outstanding shares grew by almost 550,000 shares. So far in 2014, the number has increased by nearly 1.5 million shares. This is pretty normal for a growth company, especially when executives are paid via stock options. However, from the third quarter of 2010, the number of shares has increased by over 31 million, almost 34%. The rise in share count makes it especially difficult to increase earnings per share.

In regards to non-GAAP, the share count that was used to calculate EPS in the last quarter was 140.95 million. The second quarter one year ago used 130.5 million as the number of shares to calculate EPS. Last quarter non-GAAP net income was about $16.1 million, while last year it was $26.2 million. These two factors are why non-GAAP EPS dropped to $0.11 this year from $0.20 last year.

Conclusion

While Tesla has been continuously outperforming analysts’ estimates, those estimates were brought down by Tesla’s own conservative predictions. In regards to the bottom line, the electric car manufacturer must being to show some signs of improvement. While revenue estimations are rising, EPS estimates are falling – this is mostly a result of the quickly rising operating expenses as well as the rising number of outstanding shares. Tesla is already making moves to get those costs under control with the construction of its Gigafactory, which will reduce battery costs in the future. However, the company still needs to reign in its other costs. Tesla’s current valuation, which is 5.5 times the expected sales and 80 times the estimated EPS for 2015, cannot hope to maintain its elevation if the company doesn’t do something about its profitability.